Inflation isn’t done rattling investors, leaving some sectors at risk of further downside as monetary tightening ramps up and recession risks mount. But not all sectors are necessarily losers.
Soaring prices and risks of an economic downturn are making positioning difficult, while central-bank hawkishness has sent bond volatility higher, with the risk of that extending to stocks.
“Equities have been hopeful of a decisive fall in inflation, but the new reality is that it may take time and some economic pain to materialize,” say Barclays strategists led by Emmanuel Cau. “The easy money era is over and market instability is to be expected.”
While Cau says the direction of inflation will most likely be lower in coming months, it’s the high current level that matters for central banks, so more tightening seems inevitable. This favors value stocks over growth, even if recession risk complicates positioning, he says.
“Inflation is secular, not transitory,” say Bank of America strategists led by Michael Hartnett, citing pay rises, low strategic oil supply, governments trying to control energy prices and nationalizing utilities, European fiscal packages and military spending, among other things.
As a consequence, investors continue to favor stocks with pricing power, as well as energy shares. Commodities and banks are the current winners of rising prices and interest rates, while expensive growth sectors like tech are being hurt. Meanwhile firms whose products are most at risk of a cost squeeze such as retailers, leisure providers and homebuilders are viewed as being most susceptible to slowing economies.
Retailers are the worst-performing industry group in Europe this year, and inflation has a lot to do with it. With budgets crimped by the cost of everything from food to energy to mortgages, consumers don’t have a lot left for shopping, while rising costs are eating into profitability too.
It’s “a gloomy picture for retail stocks,” says Charles Hepworth, investment director at GAM Investments. “Disposable incomes of most consumers have been massively squeezed, and trade-down substitutions into cheaper brands is hardly the best fillip for any hope of a consumer-led recovery,” he writes.
As a core part of the growth category, tech stocks have been at the forefront of this year’s global equity rout due to surging bond yields. And despite underperforming, the sector “remains very expensive,” says Barclays’ Cau. “With burgeoning signs of lower demand coming from semiconductors, demand destruction may be the next shoe to drop,” he says.
Still, market positioning is so negative at the moment, that other bear-market rallies could be seen in the event of further easing of prices. “It’s the direction of inflation that matters for share prices,” says Liberum Capital strategist Joachim Klement. “Every decline in inflation reduces some of the cost pressures companies face.”